Fannie Mae Multi Family Housing

5/28/2018 Fannie Mae Multi Family Housing

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FANNIE MAES ROLE IN THESMALL MULTIFAMILY LOAN MARKET

FIRST QUARTE R 20

EXECUTIVE SUMMARY

State of the Small Multifamily Loan Market

In the wake of the U.S. housing crisis, multifamily rental housing especially

affordable rentals is expected to play an increasingly important role in the

market due to stronger residential mortgage lending standards, more modest

consumer aspirations for homeownership, growth in households that tend to

rent (e.g., Echo Boomers, retiring Baby Boomers, and New Americans), and other

drivers. Within the rental housing market, loans to smaller rental properties

which Fannie Mae defines as loans of $3 million or less in most markets and $5

million or less in high-cost markets play a unique role.

As of June 30, 2010, the companys $34 billion book of smaller rental properties

tend to be more affordable, a key source of housing for working families, and

concentrated in urban areas in close proximity to transportation and jobs

lowering the cost of living there.

TABLE OF CONTE N

1 Executive Summary

3 Fannie Mae & Small MultifamiLoans

20 Small Loan Profitability

22 Fannie Mae Has A Relevant,Focused Role In Small Loans


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MULTIFAMILYMORTGAGEBUSINESS

Financing a ready supply of smaller multifamily rental

properties poses unique challenges, however. The lending

market is fragmented, with more than 2,600 lenders

originating an average of six small loans each1, which

impedes standardization, efficiency, and the benefits of

securitization (e.g., greater and lower-cost funding). Smaller

property financing also tends to rely on a disparate range

of borrowers, often individual investors, entrepreneurs, or

smaller commercial businesses of varying credit profiles that

invest in a limited number of properties and operate them on

a thin margin with fixed costs but potentially higher income

fluctuation risk. The disparate nature of small multifamily

property borrowers also creates financial, underwriting, and

credit issues for national investors in the loans, which limits the

supply of low-cost liquidity for these loans.

In short, while smaller multifamily properties provide

an important supply of affordable rental housing, the

1 Source: 2009 Mortgage Bankers Association data.

fragmentation and non-standardization of financing

complicates a national solution to expanding this housing.

Fannie Maes Role in the Multifamily Market

Fannie Mae plays a critical role in the U.S. rental housing

market. Our original charter in 1938 provided authority to

facilitate the construction and financing of economically

sound rental housing projects. In 1984, Fannie Mae created

a business division dedicated to purchasing multifamily

loans. Since that time, Fannie Mae has continued to provide

a consistent supply of funding to the multifamily market

through all market cycles.

Currently, amid a shortage of private investment capital and

credit for housing finance, Fannie Mae provides more than

percent of all secondary market funds available for multifam

housing finance. As of June 30, 2010, the companys $185

billion book of roughly 42,000 multifamily loans is perform

significantly better than the commercial mortgage-backed

securities market.

Fannie Maes Role in the SmallMultifamily Mark

Fannie Mae also has a history of providing liquidity for sma

rental property loans. Over the past ten years, the company

has developed and refined a dedicated, small-loan platform

to provide consistent liquidity to the small loan market and

financed $60 billion of small loans during that time. In 2007

Fannie Mae expanded its small loan team to include dedica

Fannie Mae is a leader in small

loan financing, providing a key

source of affordable rental housing

for working families close to

transportation and jobs.


3/22FANNIE MAES ROLE IN THE SMALL MULTIFAMILY LOAN MARKET

credit and production staff focused solely on the origination,

acquisition, and underwriting of small loans. We have

continued funding the small multifamily loan market through

the current challenging market cycle.

As of midyear 2010, Fannie Mae held a $34 billion book of

30,000 loans on properties with loans of $3 million or less or up

to $5 million in high cost MSAs (18 percent of total multifamily

book) or a $21 billion book of 23,500 loans on five- to 50-

unit properties (12 percent of multifamily book). Roughly 86

percent of Fannie Maes 2009 small loan book of business was

affordable to families at or below 100% area median income

and met the definition of affordable housing set forth by the

U.S. Department of Housing and Urban Development (HUD).

Fannie Maes 2010 small multifamily loan acquisitions of $2.4

billion were comparable with 2009 acquisitions of $2.2 billion.

The fragmented and disparate nature of the small multifamily

rental housing financing market poses challenges to how the

company can expand its support for this market segment in a

significant way. However, Fannie Mae remains committed to

supporting this critical housing segment.

FANNIE MAE & SMALL MULTIFAMIL

LOANS

This paper describes the unique nature of the small

multifamily market, the challenges of financing loans f

these properties, and Fannie Maes role and efforts to

support this critical source of affordable housing.

What role has Fannie Mae played

in the small loan market?

Fannie Mae aims to provide liquidity to the multifamily

housing sector in every market, every day. As a result, Fann

Maes experience, particularly in serving many of the most

challenging segments of the multifamily market, can help

inform the broader discussion about our countrys housing

finance needs.

Fannie Maes involvement in the multifamily market began

1938 as part of the New Deal when the federal government

decided to create its own mortgage association. The

purpose was to facilitate the construction and financing of

economically sound rental and for-sale housing by making

direct loans secured by first mortgages insured by the Fede

Housing Administration (FHA).

Over time Fannie Maes mission was redirected to a

secondary market role that included the authority to

purchase mortgages on multifamily rental housing and

those with conventional financing. Fannie Mae created


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a business division dedicated to purchasing multifamily

loans in 1984 and since that time, has provided liquidity

to the multifamily market for loans of all amounts.

What is a small loan in the multifamily market?

In general, the market defines small loans in two ways:

1. Unit Count which is defined as loans to apartment

buildings with five to 50 units

2. Principal Balancewhich is defined as apartment building

loans with principal balances of $3 million or less in most

markets, or up to $5 million in high cost MSAs.

Fannie Mae uses the principal balance definition, referring

to small loans as loans of $3 million or less nationwide and

$5 million or less in high cost markets like New York City and

Los Angeles. Fannie Mae believes using the principal balance

to define small loans is a more prudent way to address risk

since it allows for easier benchmarking between small and

non-small loan performance within its portfolio. Additionally,

defining small loans based on principal balance allows for

meaningful adjustments for high-cost urban areas where there

are a significant concentration of small multifamily properties.

Note: A small loan is not always synonymous with a small propert y.

Limiting the definition of small loans to properties with five to 50 units

results in the exclusion of larger subsidized affordable multifamily

properties. These larger, subsidized properties also generally benefit

from the low income housing tax credit (LIHTC) which offers below

market rents to qualified tenants and requires less debt as a result of the

subsidies they receive.

How has Fannie Mae participated in the small lo

lending market?

Fannie Mae has distinguished itself among the national

financing sources and, as the Federal Housing Finance

Agency (FHFA) recognized in its proposed 2010 Housing

Goals Rule among the GSEs, for consistently providing

dedicated resources and products to the small loan lending

market. Fannie Mae has a division dedicated to purchasing

mortgages on smallmultifamily properties. (FHFA, Final 20

Enterprise Housing Goals Report) Highlights of Fannie Mae

conventional and small loan lending activity include:

1938:Fannie Mae is chartered with specific authority

to facilitate the construction and financing of

economically sound rental housing projects.

1985:Fannie Mae begins purchasing pools

of seasoned small multifamily loans.

1988:Fannie Mae starts the Delegated Underwriting a

Servicing (DUS) model where a network of approved

lenders originate, sell, and service individual loans (bot

small and large) to Fannie Mae; this is known as flow

delivery. The DUS model relies on sharing the risk of los

with lenders to support the delegated underwriting

and align the interests of Fannie Mae and lenders.

1998: Fannie Mae begins to accept small loan

flow deliveries from non-DUS lenders.

2000:Fannie Mae adopts a 5-50 unit count flow

execution that is available to all lenders. This execution



is adopted to align with the HUD housing goal

requirement and is the first attempt to streamline

the DUS underwriting guidelines for small loans.

2001:Fannie Mae changes the definition for its small

loan platform to focus on loans with original principal

balances of $3 million or less ($5 million in certain

high-cost areas) rather than a unit count approach. The

product is rebranded 3MaxExpress and is a targeted

attempt to address the needs of lenders and borrowers

by further streamlining the underwriting guide for

small loans with separate underwriting parameters.

2007: Fannie Mae expands its support for small

multifamily loans with a larger, dedicated production

and credit team. Fannie Mae includes a separate credit

underwriting chapter in the DUS selling and servicing

guide and, for the first time, incorporates more simplified

asset management and servicing functions for small loans.

FANNIE MAE HAS A DEDICATED SMALL LOAN TEAM.

The company has historically maintained dedicated

expertise and products for specialty lending areas like

small loans and subsidized affordable housing. For more

than 10 years, Fannie Mae has developed and refined a

dedicated, small loan platform to consistently provide

liquidity to the small loan market. Fannie Mae has financed

$60 billion of small loans over the past 10 years, and

continues to provide liquidity to the small loan market

during this difficult market cycle. In 2007, Fannie Mae

expanded its small loan team to include 10 dedicated credi

and production staff focused solely on the origination,

acquisition, and underwriting of small loans nationwide.

FANNIE MAE OFFERS DEDICATED PRODUCTS.The

company consistently provides liquidity to the small loan

market through two primary products:

1. Flow Business: Fannie Mae purchases individual loans

originated by approved mortgage lenders who have

delegated authority to sell loans to Fannie Mae which th

lenders have underwritten and originated. These loans

are underwritten and serviced by the lenders according

specific, published guidelines and the lenders retain a r

position in these loans through a loss sharing agreemen

with Fannie Mae. Delegated Underwriting and Servicing

also known as DUS, is the primary platform through wh

Fannie Mae provides liquidity to the multifamily market

Within the DUS program guide, there is a dedicated

underwriting and servicing standard for small loans.

2. Pool Financing:Fannie Mae purchases pools of season

multifamily loans from DUS and non-DUS financial

institutions that originate and hold these loans on

their books. By purchasing these loans in bulk, Fannie

Mae provides a source of liquidity which enables these

financial institutions to make new loans. The loans

purchased by Fannie Mae in these seasoned pools hav

traditionally been composed mostly, but not exclusive

of small loans.


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FANNIE MAE PROVIDES CONSISTENT PRODUCTION.

The company uses prudent underwriting standards and loss

sharing with DUS lenders to acquire small loans. Additionally,

Fannie Mae requires market acceptable structures that allow

the loans to be securitized, in accordance with Fannie Maes

goal to maintain a liquid portfolio. This, in turn, enables Fannie

Mae to continue providing liquidity to the small loan market.

Flow volume has consistently averaged approximately $2.5

billion per year over the last 10 years, providing reliable

liquidity to the market. Pool financing, on the other hand,

has historically fluctuated depending on the level of small

loan activity among financial institutions. Fannie Mae has

focused more heavily on seasoned pool activity in years wh

additional volume was needed to support the corporate

housing goals needs as seen in 2003 and 2007. The followin

table shows that, regardless of the definition used (unit cou

or principal balance), Fannie Mae plays a significant role in t

small loan market.

SUMMARY OF MULTIFAMILY ACQUISITIONS

5 50 UNITS DEFINITION VS. $3MM $5MM HIGH COST PRINCIPAL BALANCE DEFINITION

YEAR Data DUS Pools Total % Total DUS Pools Total % Total Total AQSN

Loan Count 186 53 239 17% 379 68 447 32% 1,43

UPB ($M) $231 $84 $315 3% $676 $100 $776 7% $11,20

Loan Count 322 1,824 2,146 46% 703 2,186 2,889 62% 4,69

UPB ($M) $605 $718 $1,323 7% $1,638 $1,577 $3,215 17% $19,92

Loan Count 227 5,397 5,624 73% 579 5,763 6,342 82% 7,69

UPB ($M) $413 $2,893 $3,306 17% $1,354 $3,706 $5,061 26% $19,38

Loan Count 301 14,530 14,831 80% 632 15,875 16,507 89% 18,46UPB ($M) $591 $10,485 $11,075 33% $1,428 $13,201 $14,628 44% $33,28

Loan Count 335 2,128 2,463 56% 543 2,505 3,048 69% 4,43

UPB ($M) $1,660 $2,018 $3,678 20% $1,148 $2,917 $4,065 22% $18,79

Loan Count 386 6,201 6,587 75% 657 6,524 7,181 82% 8,74

UPB ($M) $1,289 $3,806 $5,095 22% $1,314 $4,546 $5,859 25% $23,4

Loan Count 558 3,101 3,659 64% 832 3,428 4,260 74% 5,75

UPB ($M) $1,207 $2,485 $3,692 17% $1,583 $3,217 $4,801 22% $22,30

Loan Count 807 10,387 11,194 78% 1,059 11,349 12,408 86% 14,40

UPB ($M) $2,142 $7,169 $9,311 20% $2,044 $9,201 $11,244 24% $46,72

Loan Count 737 2,939 3,676 54% 1,025 3,503 4,528 67% 6,77

UPB ($M) $2,684 $3,380 $6,063 17% $2,157 $4,553 $6,710 19% $34,67

Loan Count 588 230 818 33% 886 335 1,221 49% 2,47

UPB ($M) $1,068 $327 $1,395 7% $1,671 $581 $2,252 11% $19,59

Loan Count 458 87 545 36% 684 131 815 53% 1,53

UPB ($M) $856 $98 $953 9% $1,413 $217 $1,630 16% $10,32

5 - 50 Unit Definiti on

2004

2000

2001

2002

2003

Principal Balance Definiti on

2005

2006

2007

2008

2009

YTD 9/2010

BOOK Data DUS Pools Total % Total DUS Pools Total % Total Total Book1

Loan Count 4,277 19,220 23,497 56% 7,301 22,519 29,820 70% 42,30

UPB ($M) $7,524 $13,931 $21,456 12% $13,945 $19,738 $33,683 18% $186,14

Principal Balance Definiti on

9/2010 Book

5 - 50 Unit Definit ion

Note: Pools also include non-DUS negotiated contracts.1 Excludes Credit Enhancement Bonds Adjustments

SUMMARY OF MULTIFAMILY ACQUISITIONS

5 50 UNITS DEFINITION VS. $3MM $5MM HIGH COST PRINCIPAL BALANCE DEFINITION



WHAT IS UNIQUE ABOUT THE SMALL LOAN MARKET?

According to the Mortgage Bankers Association (MBA)

2009 Survey on Multifamily Lending, small loans comprised

approximately 27% of the total multifamily market by dollar

volume and 81% by number of loans. Based on Fannie Maes

$2.2 billion of small loan flow production and the MBA data,

Fannie Maes estimated market share for small loans in 2009

was 15%.

Fragmented Market:Due to their relative size, small loans

constituted about a quarter of the total multifamily dollar

volume in 2009, which equaled more than three quarters

of the number of loans originated. According to the same

MBA data, over 2,600 financial institutions financed 16,751

small loans. This means that the average financial institution

originating small loans in 2009 originated roughly six small

loans of approximately $847,000 each or an aggregate of $5.5

million in total small loan volume.

By contrast, loans over $3 million (non-small loans) were

originated by only 122 financial institutions. Those institutions

originated an average of 32 non-small loans with an averag

balance of $10 million each or an aggregate of $314 million

total non-small loan volume.

One conclusion from these statistics is that non-small loans

appear to be a core business for the institutions originating

them, while small loans appear to be a more fragmented,

complementary business that may support other relationsh

businesses participated in by these institutions.

More recent data from the Federal Financial Institution

Examination Council (FFIEC) supports this view. FFIECs June

2010 data indicates that among FDIC-insured banks and

thrifts, the top five institutions with multifamily loan balanc

accounted for 35% of total multifamily debt outstanding,

while the remaining 65% of multifamily debt outstanding w

spread among almost 6,000 FDIC-insured institutions.

The impact of such a fragmented small loan lender market

that small loans are more complicated and more expensive

to originate and underwrite than conventional non-small

Source: Mortgage Bankers Association

Average Firm Loan Size# of

Firms # of LoansVolume

($millions)Average LoanSize ($mill ions)

Average Loansper Firm

$1 million or less 2,124 11,271 $5,820 $0.5 5

$1 million to $3 million 479 5,480 $8,373 $1.5 11

$3 million to $10 million 97 2,577 $16,121 $6.3 27

Greater than $10 million 25 1,350 $22,178 $16.4 54

Total 2,725 20,678 $52,492 $2.5 $7.6

2009 SURVEY ON MULTIFAMILY LENDING


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multifamily loans. The data indicates that a broad cross

section of small loan originations are made by small local and

regional financial institutions often doing only a handful of

transactions annually in support of local lending relationships.

This characteristic creates a unique challenge for Fannie Mae,

which operates exclusively as a secondary market liquidity

provider with relatively few dedicated origination partners

(DUS lenders).

The targeted geographic focus of these local lending

institutions make them uniquely qualified to underwrite

and lend in these markets. As a result, expanding small loan

originations beyond current DUS flow would likely require

Fannie Mae to develop hundreds of specialty small loan

relationships with local and regional institutions.

With a loan origination platform based on shared loss, Fannie

Mae is limited in its ability to expand beyond its current

origination relationships. While Fannie Maes small loan

team has focused on expanding its small loan relationships,

local and regional financial institutions active in the busine

are traditional buy-and-hold banks and have historically

been unwilling or unable to participate in a loss-sharing

arrangement.

Fragmentation within the small loan origination network al

contributes to a more challenging economic cost structure

In general, since the cost to originate, underwrite, and servi

a multifamily loan does not vary significantly with loan size

small loans offer little in the way of economies of scale to

dedicated multifamily originators. As a result, originators

are less likely to focus on small loans. In addition, as a

secondary market mortgage participant, Fannie Mae does n

provide non-housing loan products. Contrastingly, financia

institutions that participate in the small loan market also ha

multiple product offerings that provide multiple opportuni

to touch their small loan customer and earn fees. This allow

them to use small loan lending in combination with the oth

products they offer, such as business lines, car loans, and

residential mortgages.

Risk Sharing and Financial Strength:The cornerstone

of Fannie Maes multifamily platform is the loss sharing

relationship with the lenders who originate, sell, and servic

loans. By committing to share in potential loan losses, lende

are motivated to prudently underwrite and service loans

delivered to Fannie Mae. This heightened responsibility and

liability on the part of the DUS lenders ultimately benefits

Fannie Maes Multifamily platform of

loss sharing with lenders, benefits

investors, owners, and tenants.



investors, owner/operators, and tenants by ensuring more

sustainable multifamily housing. However, for Fannie Mae

to accept shared loss with a DUS lender, that lender must

demonstrate sufficient organizational and financial knowledge

in the form of infrastructure and capital reserves to make

good on those loss-sharing obligations.

Fannie Mae maintains strict financial and organizational

requirements to qualify for and maintain DUS selling and

servicing authority. In many cases, the minimum DUS capital

and infrastructure requirements dissuade or disqualify local

and regional lenders from participating in DUS. While Fannie

Mae could choose to lower its counterparty credit standards

or not require loss sharing at all to expand its origination

platform, our experience has shown us that maintaining

delegation and enforcing minimum capital standards is

prudent and commercially reasonable.

To support the small loan lending market in the past, Fannie

Mae had selectively entered into lending relationships with

small loan lenders without loss sharing. Our experience with

that showed us that the performance of these loans was

generally worse and asset management by the servicer was

weaker because the lender did not have skin in the game.

Based on these mixed results and the success of loss sharing

over the last 20 years, Fannie Mae now requires all small loan

lenders to participate in loss sharing with Fannie Mae. This

limits the range of lenders who are willing and eligible to w

with Fannie Mae, but supports sound and responsible lend

Small Loan Borrowers:Having financed over $60 billion o

small loans over the last 10 years, our experience has led us

the conclusion that the small loan borrower is fundamenta

different than a conventional or non-small loan borrower

and our partners generally agree.

According to one of the largest multifamily real estate

brokerage firms in New York City, the small loan borrower

generally a small business owner, who has a small portfolio

of multifamily real estate, typically a local or regional owne

operator that is not as financially savvy or as sophisticated

in the commercial real estate market, and may not have the

financial strength of a large traditional multifamily borrowe

Many borrowers have additional jobs and sources of incom

and they or their relatives often live in the properties.

Based on past experience, and the experience of our

partners, Fannie Mae has concluded that small loan

borrowers have unique characteristics. First, small loan

borrowers often do not employ professional property

management, but choose to maintain and manage

properties themselves because smaller properties may not

support the cost of third party management. However,

borrowers may take on this responsibility without any

significant experience or expertise. Looking at Fannie Mae


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acquisitions through September 2010, only 57% of small loan

borrowers employed professional property management

compared to 85% for non-small loan borrowers.

Second, small loan borrowers are more like single family

borrowers than traditional multifamily borrowers. Unlike larger

multifamily loans that are driven almost exclusively by cash

flow, Fannie Mae has observed, through analysis of its own

small loan delinquencies, that a small loan borrowers ability

to repay is driven by the strength of the property cash flow, as

well as the borrowers own financial strength and repayment

history much like a single family loan. In fact, Fannie Mae

has observed that a majority of small loan delinquencies are

correlated to poor borrower financial strength and experience

rather than poorly performing properties or slumping markets.

This dynamic makes sense when one considers the cash

flow margin for error in a small multifamily property. If a 10-

unit subdivided brownstone property has one vacancy for

more than 30 days, cash flow could drop to the point where

there is not sufficient income to pay the mortgage. In this

case, a small loan borrowers personal worth or self-liquidity

becomes a critical source for debt repayment. By contrast,

one or two vacancies for more than 30 days in a 100-unit low

rise apartment would not significantly impair cash flow to

the point that debt repayment is at risk. In support of this

assertion, a recent examination of Fannie Maes small loan

portfolio indicated that 64% of all small loan delinquencie

were directly related to borrower credit issues.

Underwrite the Borrower and the Property:Given the

importance of underwriting both the borrower and the

property in a small loan transaction, Fannie Mae requires

supplemental information regarding the borrower that

it may not typically require for a non-small DUS loan,

including credit score (FICO) and unique requirements

around net worth and liquidity. Regional and community

banks often have broad banking relationships with

their small multifamily borrowers, and as such, make

multifamily property loans on the security of the broader

banking relationship, not just the rental property.

In essence, these institutions are relationship lenders,

operating much closer to their borrowers and often having

broader experience with them that allows for a lighter

touch. In a recent survey of several active regional and loca

small loan lenders, Fannie Mae found that looking solely

at the terms for an individual multifamily property loan, its

credit standards and due diligence requirements were mor

conservative across the board. This narrower range of lendi

products and tighter credit approach has limited Fannie Ma

small loan market opportunities. However, we believe this i

prudent approach to credit, especially in light of the delega

nature of the program.



Given the inherent risks with the typical small loan

borrower, Fannie Mae has substantially enhanced the

small loan underwriting criteria to address these risks in a

streamlined manner. All Fannie Mae lenders comply with

the same requirements. This allows this product to take a

commoditized approach and has made Fannie Mae more

successful with this market.

Small Loan Products and the Secondary Market:Many

small loan lenders take a buy-and-hold approach to the

business holding small multifamily loans on their balance

sheets in lieu of selling them into the secondary market. In the

1980s, savings and loans and thrifts aggressively penetrated

the small multifamily market. Credit losses that these

institutions experienced in the commercial real estate crisis of

the late 1980s drove many of these small institutions out of the

market. However, several of the larger depositories survived

and continued to consolidate and grow their presence in

small multifamily lending throughout the 1990s and 2000s.

These institutions included Independence Community Bank

(Sovereign Bank) and New York Community Bank in New York,

Washington Mutual and World Savings on the West Coast, and

LaSalle Bank in Chicago.

With the recent mortgage market meltdown, many of

these banks were acquired or consolidated into other

institutions and their small multifamily lending platforms

were reconsidered. However, several remain and are

extremely active in this space. Both Banco Santander, with

the acquisition of Sovereign Bank, and JP Morgan Chase,

with the acquisition of Washington Mutual, continue to

originate and add small multifamily loans to their balance

sheets. These banks like the reliable returns and steady cred

performance of multifamily real estate assets compared

to other commercial lending products. By contrast, while

these banks balance sheet capacity allows them to pursue

a buy-and-hold strategy, Fannie Mae has very limited

balance sheet capacity to hold loans and, in fact, has been

mandated to reduce its existing port folio. This creates a

significant competitive advantage for the largest banks

that Fannie Mae competes with for small loan assets.

So how does Fannie Mae participate in the mark

Given current constraints, Fannie Mae is only able to

participate in lending activities that allow for the securitizat

of the loans into Fannie Mae guaranteed mortgage-backed

securities (MBS) and the sale of those MBS to investors. For

Fannie Mae to securitize loans, they must be in a standardiz

or plain vanilla form that is broadly acceptable to MBS

investors typically a straightforward, 10-year, fixed-rate lo

with standard prepayment term. Without that homogeneit

loans are difficult to securitize and unlikely to attract invest

willing to purchase the security. While this is not an issue fo

conventional or non-small loans, it does present challenges


12/2212


for the small loan market where commercial banks and small

loan borrowers favor shorter term loan products with non-

traditional MBS terms.

Most financial institutions like to match their asset and liability

profile and, therefore, shorter duration loans align with their

short-term deposit profile. Many community banks and larger

portfolio lenders offer short-term products with flexible loan

terms to small loan borrowers. Flexibility around loan terms,

amortization periods, prepayment options, and periods of

fixed-rate or variable-rate payments are attractive to small

loan borrowers. The prepayment structure may be yield

maintenance, step-down, or based solely on a certain num

of days of interest. The loan term could be 3, 5, 7, or 10 year

And, there could be additional flexibility built into the prod

such as extensions at the borrowers option, the option to

remain in a fixed-rate period, or to convert to a variable rate

of interest. These are terms, however, that Fannie Mae cann

readily offer because of securitization rules and the lack of

investor demand for most of the flexible loan terms.

The variability of terms and condition for small loans is

supported by a Fannie Mae market survey completed in

September 2010 and summarized in the following table.

Source: Market Rate Sheets (as of 9/20/10)

Min / Max Fixed

Lender Loan Amount Products Terms Prepayment

3 2,1

Union Bank of $400K - $5MM Hybrid ARMs 5 3,2,1

Cali fornia 7 4,3,2,1

Date: 8/18/2010 10 5,4,3,2,1

15 5,4,3,2,1,1,1,1

JPM Chase > $1MM Hybrid ARMs 3 3,2,1

Date: 9/13/10 5 5,4,3,2,1

7 5,5,4,4,3,2,1 or YM

10 YM

Capital One > $500K 5 + 5 5 5,4,3,2,1

Date: 9/3/10 7 + 5 7 5,5,5,4,3,2,1

NY Community Bank > $500K 5 + 5 5 5,4,3,2,1

Date: 9/3/10 7 + 5 7 5,5,5,4,3,2,1

10 10 5,5,4,4,3,3,2,2,1,1Dime ofWilliamsburgh > $500K 5 + 5 5 5,4,3,2,1

Date: 9/3/10 7 + 5 7 5,5,5,4,3,2,1

Signature Bank > $500 K 5 + 5 5 5,4,3,2,1Date: 9/3/10 7 + 5 7 5,5,4,4,3,2,1Investors SavingsBank > $500 K 5 + 5 5 5,4,3,2,1

Date: 9/3/10 7 + 5 7 5,5,5,4,3,2,1

10 10 5,5,4,4,3,3,2,2,1,15-year / no

option 5 4.5 YM

Sovereign Portfolio > $500 K 5 + 5 5 4.5 YM

Date: 9/3/105-year / no

option 5 5,4,3,2,17-year / no

option 7 6.5 YM10-year / no

option 10 9.5 YM

SMALL MULTIFAMILY LENDERS COMPARABLE TERMS AND PRODUCTS



Among those surveyed, Union Bank of California is a

west coast bank and JPM Chase lends nationwide with a

concentration on the west coast and New York. The other

banks are based in New York. In general, these lenders

consistently offer hybrid interest rate terms, loan terms less

than 10 years, options to extend loan term, and declining

prepayment schedules. All these features offer borrowers

added flexibility, but largely eliminate these loans from

consideration for securitization.

Fannie Maes most competitive product is the 10-year fixed-

rate balloon with 30-year amortization and 9.5 years of

yield maintenance (which means that the borrower cannot

prepay the loan before 9.5 years without making the investor

whole). Because of the refinance or balloon risk of short-

term products, Fannie Mae has underwriting guidelines such

as interest rate floors and stressed interest rate exit tests to

minimize this risk; as well as pricing and credit structures that

favor longer duration products. There is also a strong MBS

market demand for longer-term products and Fannie Mae is

able to quickly and efficiently securitize these loans.

Securities law restrictions, such as the inability to provide

payment relief for a borrower by modifying loan terms,

except under clearly defined conditions, or the inability

to transfer a recourse loan, can be burdensome to a

borrower looking for flexibility. Portfolio lenders are able

to meet the small loan borrowers desire for flexibility.

Additionally, products offering borrower options, such as

ability to extend a loan term or customize prepayment

premiums, may be ineligible for securitization or may

be expensive or illiquid in the capital markets.

During the Commercial Mortgage-Backed Securities (CMBS

boom of the mid-2000s there were several small loan

securitization programs including LaSalle Bank, Washingto

Mutual, and Sovereign Bank. The loans that were securitize

these programs were long-term products without prepaym

flexibility and were not priced as attractively for borrowers

the lenders portfolio programs. In short, the standard smal

multifamily loan product originated by banks is not easily

securitizable. However, Fannie Mae has identified a segmen

the market where borrowers will accept long-term fixed rat

loans that can be placed into mortgage-backed securities.

Unique Small Loan Market Limits Fannie Maes Role: Ba

on Fannie Maes small loan flow volume of $2.2 billion in 20

Fannie Mae estimates that our small loan market share is 15

Although this is lower than the conventional multifamily lo

market share of 40% in 2009, it is still a relevant volume and

provides much needed liquidity to the market.

Overall, lenders, borrowers, and products are unique in the

multifamily small loan market versus the larger, convention

multifamily loan market. Fannie Mae has embraced these

differences, created a dedicated team, and partnered with t


14/2214


top small loan lenders to offer an effective, fixed-rate product

that many borrowers demand. Fannie Maes participation in

small multifamily loans is valuable but the liquidity we can

provide is limited by the nature of the market.

WHY IS THE SMALL MULTIFAMILY MARKET IMPORTANT

TO FANNIE MAE?

It is important because small loans support affordable

housing. Fannie Mae has chosen a business model that focuses

on supporting the breadth of the rental housing market,

with a particular focus on rental housing for working families.

Unlike other market participants that have moved in and out

of the small loan multifamily space, Fannie Mae has always

considered small multifamily lending an important strategic

business because a preponderance of lower income and

working families live in small multifamily rental properties.

Small multifamily rentals are concentrated in urban areas,

particularly in the northeastern United States and Southern

California, and as such provide affordable housing in close

proximity to transportation and jobs. Small multifamily rentals

also tend to be older properties, with more than half over 30

years old.

The importance of small loans and the affordability they

provide is demonstrated by Fannie Maes small loan book, 86%

of which is affordable to families earning at or below 100%

area median income (AMI).

HOW IS AFFORDABLE DEFINED?

Housing is considered affordable if a household spends

no more than 30% of gross income for rent. However, the

following chart shows a different scenario that households

must routinely spend well over one-third of gross income

to be able to live in a two-bedroom apartment, especially in

high-cost areas.

For example, in Los Angeles, a household earning 50%

of AMI, $34,100, must spend over 57% of income to be

able to afford the typical market rate rent for a two-

bedroom apartment of $1,627. A household earning

$34,100 can afford to spend no more than $853 per

month. Only households earning 80% to 100% of AMI can

comfortably live in the typical market rate apartment.

What is striking in the following comparison is not the

difference in asking rents, but the difference in the estimate

household income needed to afford the corresponding

rental rates. Based on this difference, it seems likely that

many households in these high-cost metro areas are not

actually earning the income needed to afford the two-

bedroom market rate rent apartment, but rather are spend

more than one-third of gross income to pay the rent.

Fannie Mae and Affordable Workforce Housing:These

three metro areas may have higher costs of living on averag

but there are still rental units affordable across the spectrum


15/22


16/2216


WHAT IS THE CREDIT PERFORMANCE OF SMALL

LOANS?

Fannie Mae Small Loan Book of Business: Fannie Mae has

a long history of providing liquidity to the multifamily small

loan market as demonstrated by the size of its current book of

business. As of June 30, 2010, Fannie Maes total multifamily

book of business was approximately $185 billion comprised of

over 42,000 apartment loans. The small loan book of business

for that same period totaled approximately $34 billion (18%

of total book) comprised of approximately 30,000 individual

small loans (71% of total loan count).

Small Loan Geography:Small multifamily loans tend to be

concentrated in large metropolitan areas, which traditional

have low home ownership rates and high demand for

affordable rental housing. According to PPR (Property and

Portfolio Research) data, New York City has the largest

concentration of small multifamily buildings in the US. With

the metropolitan statistical area (MSA) there are an estimat

2,000,000 small multifamily units. This is not surprising for a

city with a home ownership rate of approximately 30%.

Among other large cities, the Los Angeles MSA has

approximately 1,080,000 small multifamily units and the

Chicago MSA has approximately 632,400. From a loan

FANNIE MAES BOOK OF BUSINESS UNITS IN SPECIFIED MARKETS

SEGMENTED BY AFFORDABILITY TO AREA MEDIAN INCOME AMI

Source: Fannie Mae, December 2009 Book of Business

6,363 10,987 43,979

15,088

31,385

61,510

38,113

83,308

110,527

29,423

105,076

96,042

15,453

112,244 141,755

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%Total Units:

San Francisco-Oakland-Fremont, CA Los Angeles-Long Beach-Santa Ana, CA New York-Northern New Jersey-Long Island,

NY-NJ-PA

Units below 50% of AMI 50% of AMI to 60% of AMI 60% of AMI to 80% of AMI

80% of AMI to 100% AMI Units above 100

104,440 343,000 453,813



production point of view, Los Angeles recorded the highest

dollar volume of small multifamily loans financed in 2008, with

New York and Chicago close behind.

Following geographic market trends detailed to the right,

Fannie Maes multifamily small loan book of business is also

highly concentrated in the Los Angeles and New York MSAs.

While this type of geographic concentration would typically

create concern over diversity risk in the portfolio, multifamily

small loan real estate has historically performed well in these

MSAs. The chart shows the top five MSAs where the small loan

book of business is distributed.

Small Loan Credit Statistics and Performance:Despite

relatively lower loan leverage in the small loan book, debt

service coverage (DSCR) a relative measure of the amount

of cash flow needed to support debt service payments for

the small loan book slightly lags the total multifamily book.

This relative under performance is attributable to the unique

cash flow challenges smaller properties face, like the more

dramatic effect on cash flow that vacancies have on small loan

performance.

Fannie Maes small loan serious delinquencies (SDQ) loan

that are 60 days past due rose to 1.01% in the second qua

of 2010. However, if you disaggregate the seasoned pool

business from the DUS small loan business the two busine

segments that make up Fannie Mae small loan lending th

seasoned pool book of business experienced an SDQ rate

of 1.44% compared to a more favorable 0.73% SDQ rate for

the DUS flow small loan portfolio. These compare relatively

favorably to an SDQ rate for the total multifamily book of

0.80% in the same period.

FANNIE MAE SMALL MULTIFAMILY

BOB MARKET GEOGRAPHY

AS OF JUNE 30, 2010

Source: Fannie Mae

Los Angeles

27%

New York22%

Other39%

Chicago3%

San Francisco5%

Seattle

4%

Small Loans

Non-SmallLoans

TotalMultifamil

WAVG Loan to Value (LTV) at Origination 58% 68% 67%

WAVG Debt Service Coverage (DSCR) at Origination 1.54 1.37 1.40

Data as of June 30, 2010


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Despite slightly less favorable credit performance in the Fannie

Mae small loan book compared to the total multifamily book,

Fannie Maes small loans demonstrate better per formance

than the overall multifamily performance of loans held by

other lenders active in the small loan space. For example, SDQ

rates for bank portfolios through the second quarter of 2010

were approximately 3.88%. Since these rates are based on

a 90-day past due standard compared to Fannie Maes 60-

day past due standard, they can be considered conservative.

Fannie Mae multifamily also outperformed the CMBS market,

which registered 13.18% delinquency through Q2 2010.

Fannie Mae attributes this strong performance compared to

its bank and CMBS competition to be attributable directly

to standardized underwriting and credit guidelines for small

multifamily loans and the strength of credit delegation and

shared loss provided by the DUS lenders.

Property Condition and Small Multifamily Loans:In

addition to the increased borrower risks, property conditio

is a significant factor that affects small loan performance.

More than half of small rental buildings in the US are over 3

years old and much of the inventory is in need of substantia

repair. Approximately 57% of the Fannie Mae small loan bo

was built before 1970 and faces many of the same property

condition challenges as the rest of the market.

Many individual small rental owners do not have the

resources to preserve and improve small rental properties.

However, without sufficient capital to maintain their

Source: Federal Financial Institution Examination Council as of June 30, 2010

Name

Total

Assets

Loans Secured by 5

or more family units

SDQ Rate

(Past 90 days

1 JPMorgan Chase Bank, National Association 1,568,093,000$ 33,236,000$ 3.82

2 New York Community Bank 39,788,713$ 16,496,224$ 2.30

3 Wells Fargo Bank, National Association 1,073,280,000$ 10,061,000$ 4.03

4 Bank of America, National Association 1,518,957,843$ 8,252,307$ 2.84

5 Citibank, National Association 1,157,877,000$ 7,251,000$ 5.97

6 Sovereign Bank 72,580,147$ 5,497,587$ 5.04

7 Capital One, National Association 123,523,320$ 5,036,669$ 0.69

8 Regions Bank 131,010,846$ 4,169,070$ 7.42

9 U.S. Bank National Association 278,464,643$ 3,756,228$ 5.07

10 PNC Bank, National Association 251,075,292$ 2,728,760$ 13.47

11 OneWest Bank, FSB 27,898,129$ 2,476,562$ 2.26

12 The Dime Svgs. Bank of Williamsburgh 4,134,786$ 2,473,551$ 0.47

13 M&I Marshall and Ilsley Bank 47,530,839$ 2,442,381$ 1.93

14 Astoria Federal Savings and Loan Association 19,639,969$ 2,409,258$ 2.34

15 Union Bank, National Association 83,842,126$ 2,335,408$ 6.27

FDIC INSURED FINANCIAL INSTITUTIONS

LARGEST HOLDERS OF MULTIFAMILY DEBT $000S



buildings the properties deteriorate, tenants are exposed

to challenging living conditions, and vacancies increase

leading to curtailed cash flow and a higher incidence of

delinquency. The property condition of the Fannie Mae

small loan book is slightly worse than the non-small loan

book. A property condition rating of 1 is the strongest,

a rating of 5 is the weakest, so the lower the rating the

worse the condition. The weighted average property

condition for small loans is 1.86 versus 1.70 for non-small.

Due to the challenges related to property condition for small

loans, Fannie Mae monitors this portfolio closely to assure

sustainable and safe housing for tenants. Fannie Mae also has

strict guidelines related to property condition at origination

to assure that as small loans are delivered, they adhere to this

quality for tenants and to limit deferred maintenance issues.

Consistent with Fannie Maes portfolio performance,

according to data from University Neighborhood Program,

UNHP, a NYC nonprofit that tracks property code violations in

the five boroughs, smaller properties ( 50 units) have higher

incidences of property code violations than larger properties

with more than 50 units. A Building Indicator Project Score

(BIP) of 800 or higher is considered to be a significant code

violation issue. And, as the table shows, properties with less

than 50 units have higher average of violations per unit, 1.4

vs. 0.32 for larger properties.

Based on these concerns, Fannie Mae believes it is prudent

to apply a strict approach to property condition for small

loans. Fannie Maes approach is more conservative than oth

portfolio lenders. Using the UNHP data, 5.7% of all properti

in the NYC market have BIP scores > 800 while only 3.17%

of Fannie Maes Book of Business has a BIP score > 800. This

shows that Fannie Mae takes a more prudent underwriting

approach to property condition which helps to ensure the

safety of tenants.

Fannie Mae has also found that the credit performance of o

small loan book, while not as strong as the larger loan book

is still good relative to the market. The fact that Fannie Mae

has a dedicated credit team focused on this unique produc

has served the company well. Although Fannie Maes credit

guidelines are often stricter than portfolio lenders, Fannie

Mae believes this is a prudent approach and is consistently

Source: University Neighborhood Program Code Violation Data for Properties in the NYC Market

NYC MarketBuilding Size

TotalBuildings

Units800+ BIP

Score800+ BIP %

Average TotalViolations per

Unit

50 Units 8,847 1,212,411 396 4.50% 0.32

Totals 57,857 1,948,547 3,300 5.70% 0.73


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calibrating issues relating to markets, property condition, and

borrowers in the small loan space.

SMALL LOAN PROFITABILITY

A significant challenge associated with managing the small

multifamily loan business is the high fixed costs at origination

and sustained costs after closing for servicing, asset

management, and special asset management for both Fannie

Mae and the lenders. Both the lender and Fannie Mae work to

streamline these costs and create economies of scale in order

to sustain a profitable ongoing business.

Fannie Mae has streamlined the upfront underwriting

requirements to make these loans less expensive for lenders

to originate. While the asset management and servicing

costs are less for a $2 million loan than for a larger loan, fixed

costs associated with managing these small loans cause the

profitability to be greater for the larger loans. Additionally, loss

severity for small loans is higher than for larger loans; it takes a

comparable level of effort and expense to work out a $2 million

dollar loan in foreclosure as it does a $20 million dollar loan, thus

driving up the percentage amount lost on each small loan.

Through our current small loan strategy and pricing, Fannie

Mae has established a model where both the lenders and

Fannie Mae are targeting profitable small loan business. We

are constantly monitoring this profitability to assure that we

are structured and priced effectively.

Lender Small Loan Profitability:Thin margins and limited

profitability for the lenders prove challenging in the small loa

market. Lender income is based on a percentage of the loan

amount via origination fees, trade premiums, and servicing

fees. The smaller the loan size, the harder it is to be profitable

Many lenders have created economies of scale that allow the

to enter into this business. Based upon an informal survey

of Fannie Maes small loan lenders we have summarized the

origination and servicing cost and profitability to illustrate so

of the challenges associated with managing this business.

Origination Costs:The cost to originate and service a sma

loan is high in relation to the loan amount and generated

revenue. As shown in the sample profit and loss statement

(P&L), the expense ratio for a $1 million loan is roughly

Sample P&LAssumed Deal Terms

Deal TermsLoan Amount 1,000,000 3,000,000 10,000

Origination Fee 1.0% 1.0% 1

Loan Term 10 10

Purchase Price 103.50 102.00 10

Income Analysis *

Premium (net) 35,000 60,000 200

Origination Fee 10,000 30,000 100

Ancillary Income (0.35%) 3,500 10,500 35

Borrower Reimbursed DD Expenses N/A N/A 27

Application Fee 5,000 5,000 12

TOTAL REVENUE $53,500 $105,500 $374

Due Diligence Expenses ** 9,000 9,000 39

Salaries and Incentives 32,700 32,700 125

Origination Fee 10,000 30,000 100

Capital Reserve 1,160 3,480 11

Operating Expenses 22,250 22,250 70

TOTAL EXPENSES 75,110 97,430 346

NOI (21,610) 8,070 28

* Average income and expense data above provided by a DUS

lender currently active in small balance lending for Fannie Mae.

** See the following chart for details



7.5% vs. 3.2% for a $3 million loan and 3.5% for a $10 million

loan. As shown in the P&L chart, Fannie Mae has streamlined

the origination costs to make small loans less expensive to

originate and therefore profitable for lenders.

The chart to the right is a sample of typical application fees

and due diligence costs associated with underwriting a $1

million small loan and a $10 million loan.

Servicing Costs:On average, the cost to asset manage

and service a small loan is lower than that of a larger loan.

According to a DUS lender experienced in small balance

lending, the average cost to service a $1 million loan is

roughly $2,200 while the cost to service a $10 million loan is

approximately $3,600. However, the loss severity for small

loans is higher than for larger loans. It takes the same level

of effort and expense to work out a $1 million dollar loan

in foreclosure as it does a $10

million dollar loan, thus driving loss

severities up for the small loans.

Assuming the same loan amount terms, the Sample Asset

Managment/Servicing chart highlights the net present valu

breakeven cost of servicing fee income for the expenses of

servicing a loan. The breakeven servicing fee to service a $1

million loan is 25 basis points annually versus 8 bps and 4 b

for $3 million and $10 million loans, respectively. Therefore,

sustaining profitability for servicing smaller loans is much

more challenging.

Small Loan DUS Loan$1MM $10MM

DUE DILIGENCE COSTS:

Appraisal: $2,500 $5,50

PNA: $1,200 $2,00

Phase 1: $0 $2,00

Seismic $0

Legal & Docs:* $4,250 $29,35

Title Insurance** $0 $

Other (credit score): $50 $5

Processing: $1,000 $1,00

TOTAL: $9,000 $39,90* Legal for DUS loans includes lender legal fees, UCC Searches of $850,Survey of $4,000 to $10,000 and borrower legal fees of $10,000, whichincludes opinion letter.** Title insurance costs for small loans range from $4,000 to $11,000 andare paid by the borrower. This includes UCC Searches which are also paidby the borrower. For large loans the average cost of title is $17,500.

SAMPLE ASSET MANAGEMENT / SERVICING

Assumed Deal Terms

Deal TermsLoan Amount 1,000,000 3,000,000 10,000,0

S-Fee to lender (per pricing memo) 0.60 bps 0.55 bps 0.55 b

Estimated per loan cost to service $2,200 $2,200 $3,6

Loan Term / Amortization 10 / 30 10 / 30 10 /

Net Present Value (NPV)Servicing Fee Income / Expenses

Minimum servicing fee requiredto break even 0.25 bps 0.08 bps 0.04 bNPV servicing income based on breakeven s-fee $19,786 $18,966 $31,6

NPV Servicing Expenses $19,274 $19,274 $31,5

Profit / (Loss) $512 ($308) $


22/2222


FANNIE MAE HAS A RELEVANT,

FOCUSED ROLE IN SMALL LOANS

Fannie Maes 2010 small multifamily loan acquisitions are

expected to be comparable with 2009 acquisitions of $2.2

billion. The company estimates this will be consistent with our

2009 small loan market share of 15%. This makes Fannie Mae

one of the largest providers of financing for small multifamily

loans in the country and one of the only secondary market

participants buying small loans. While several of the large bank

portfolio lenders, such as JP Morgan Chase and Sovereign

Bank, have entered and exited the small multifamily market in

the past few years, Fannie Mae has been a consistent source

of liquidity with a $34 billion book of 30,000 loans on small

multifamily properties as of midyear 2010.

Fannie Mae continues to have a dedicated team of people

committed to providing liquidity for strong, small loan

properties and focused on borrowers who want long-term,

fixed-rate financing. With over 25 years of history in small

multifamily lending, Fannie Mae plans to maintain this

leadership role by supporting our DUS lenders and non-DUS

small loan lenders.

CONTACTS

For more information about Fannie Mae small multifamily

loans, please visit eFannieMae.com. For a list of our small

loan lenders, https://www.eFannieMae.com/mf/refmaterials

lenderinfo/smloanlenders.jsp.

Opinions, analyses, estimates, forecasts and other views of Fannie

Maes Multifamily Mortgage Business Economics and Market Research

Group (MRG) included in these materials should not be construed

as indicating Fannie Maes business prospects or expected results,

are based on a number of assumptions, and are subject to change

without notice. How this information affects Fannie Mae will depend

on many factors. Although the MRG bases its opinions, analyses,

estimates, forecasts and other views on information it considers

reliable, it does not guarantee that the information provided in

these materials is accurate, current or suitable for any particular

purpose. Changes in the assumptions or the information underlying

these views could produce materially different results. The analyses,

opinions, estimates, forecasts and other views published by the MRG

represent the views of that group as of the date indicated and do not

necessarily represent the views of Fannie Mae or its management.

Fannie Mae Multi Family Housing

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